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TE11 - How to Use the COT Report for Trading

"The Commitment of Traders report is something that we have covered in the previous articles. They give you the basic foundation of what the Commitment of Traders report is all about and how this information can be used. In this article, we give you more insights into how you can use the Commitment of traders report into understanding the implications in the market trends. By analyzing the data, you will be able to see how the commercial and non-commercial positions will influence the market trends and how you can use this information for trading. This article gives you a basic outline of many traders make use of the CoT report in their day to day trading. We also outline some of the limitations of using the Commitment of traders report in your daily forex trading. By the end of this article, you should have a fair idea of reading the CoT report and understanding what it means in the technical analysis of the markets."

When it comes to using the CoT report for your trading, you can have many different ways of interpreting the data. The most famous method was outlined by Larry Williams in his published books.

Since then, traders have been looking at ways to further gain the edge in the forex markets by looking at the Commitment of Traders report. But before you begin to analyze the CoT data, you need to understand what the data is telling you.

As you might have already read in the previous articles, there are three main reportable categories in the CoT report. Among the three, the commercials are known to be the most knowledgeable of all.

This is because the commercials are the main group who have a stake in the underlying delivery of the commodity. These are the most important category among the three that you should pay attention to.

It can give you insights into what they expect prices to be. It also gives information on the supply and demand basics.

Another group that you should be paying attention to is the speculators or the non-commercials. This group, as we covered previously do not have a stake in the underlying commodity. They are merely there to take advantage of the volatility. They are not interested in the delivery of the underlying contract.

Therefore, when you use the CoT report, you will be largely focusing on the commercials and the non-commercials. Typically, both these categories take on the opposite side of the trades.

The logic behind this is simple.

If producers expect that prices will fall, they are very likely to lock in the currency price. Thus, they will be net long on the positions.

On the other hand, speculators, will remain net short as they would like to take advantage of the falling prices.

The chart below illustrates this point. The chart picture is taken from a website, FreeCotData.com which is one of the simplest charts of the CoT data representation.

TE11 01 CoT Data Comm NonComm

Example CoT data for Gold commodity futures

 

In the above chart, you can see that the commercials and non-commercials have opposite directions of the trade. What this means is that, when commercials are long, non-commercials are short and vice versa.

But this is not all there is to it. You will also need to see how the positions have changed compared to the previous periods.

Typically, when non-commercials have extreme positions, it indicates that the trade is crowded. This is where you can see price reversing the trend or at the very least, posting a correction.

If you observe the chart closely, you will find that whenever the non-commercials are at an extreme high or low, it coincides with the reversal in the price.

For example, the periods between 2015 and 2016 saw the speculators or the non-commercials reaching an extremely low short position. Based on the logic, it means that we could expect to see a reversal in the price of gold.

Now let’s look at the gold chart on a monthly time frame below.

TE11 02 Gold Monthly Chart

Monthly Gold Chart

 

In the above chart, we have highlighted the period between 2015 and 2016. You can see how the non-commercials’ extremely net short position resulted in a low being formed just before price bounced higher.

This is the information that trades find valuable. Of course, on the above chart you can see the time horizon is a year. But if you dig deeper into the CoT report on a week to week basis, you will find that at some point, the non-commercials’ positions reached at a historic level on the short side.

This leads to a bounce in the price and results in a possible change of direction for a certain period of time.

Limitations of the CoT report

While the Commitment of Traders report can be used across most of the markets, the data is limited to the following when it comes to the forex markets.

FX Futures – The FX Futures markets cover the major currencies such as the Euro, Yen, GBP, AUD, NZD, CAD and the CHF. If you want to trade cross currencies, then it becomes a bit more complicated

Time frame – The CoT report is published on a weekly basis. Therefore, the report is useless if you look at the smaller intraday time frames. The CoT report is more ideal if you are long term investor or a swing trader.

Timelag - There is a significant time lag, of about three days. Within these three days, depending on the market volatility, the positions can change quite a lot. This is something to bear in mind, although it doesn’t happen all the time.

Read 863 times Last modified on Saturday, 03 August 2019 08:01

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